Week in review

Hawkish shiftThe corporate credit markets were somewhat mixed this week amid a hawkish shift in the U.S. Federal Reserve narrative, with fixed-rate assets and higher duration investments experiencing declines.1 High yield bonds weakened amid rising expectations of a rate hike at next week’s FOMC policy meeting, higher Treasury yields and a growing new issuance calendar, with high yield bonds now providing a month-to-date return of approximately -1.2%.2,3 In the largest weekly outflow since November, investors withdrew approximately $2.1 billion from high yield bond mutual funds during the week ended March 8.4 This brings the year-to-date outflow to approximately $1.2 billion even as high yield bond returns remain firmly in positive territory.4Senior secured loans were largely stable this week amid another large weekly inflow into bank loan mutual funds and ongoing demand for assets that help to mitigate the effect of rising rates.5 Bank loan mutual funds recorded an inflow of $1.2 billion this week, marking the 17th consecutive weekly inflow since November 16, with a total of $17.1 billion in inflows over that span.4 Year to date, senior secured loans are providing returns of approximately 1.3%.5 By comparison, high yield bonds and investment-grade corporate bonds are providing returns of approximately 1.7% and 0.0% over the same period.1,6

Commodity volatility
A decline in oil prices weighed on energy high yield bonds this week, with energy senior secured loans registering far more modest declines.7 Following an 8.2 million barrel increase in U.S. crude supplies, oil prices declined to below $50 per barrel for the first time since December, helping energy high yield bonds to a month-to-date return of -2.2%.8,9 Year to date, energy high yield bonds have now returned 0.4% after returning approximately 38.4% in 2016.9 The reaction to this week’s commodity price volatility was far more muted in the senior secured loan market, with energy senior secured loans declining approximately 0.15% in the week ended March 9.10 Year to date, energy senior secured loans remain an outperformer, providing returns of nearly 6.0% after returning 37.2% in 2016.10 Following this week’s price declines, energy high yield bonds currently yield 6.7%, down from 21.0% in February 2015, while energy senior secured loans are yielding approximately 11.9%.11,12 For a longer-term perspective, in a report released this week, the International Energy Agency said the global oil supply could struggle to keep pace with demand beginning in 2020, risking a sharp increase in prices unless new projects are approved soon.13

Baked in
Ahead of next week’s FOMC policy-setting meeting, investors were looking to Friday’s nonfarm payrolls report for further signals about the prospect of a rate hike. Despite a weaker-than-expected rise in wages, a strong headline number likely clears the way for the Fed to move next week.14 Nonfarm payrolls rose by 235,000 in February against expectations of 200,000.15 Meanwhile, the unemployment rate ticked lower, labor force participation rose slightly and average hourly earnings rose 0.2% against analyst expectations of 0.3%.15 While the somewhat modest uptick in wages suggests a continued tightening in the labor markets, it also indicates inflation pressures remain contained. With a March rate hike now priced in, investors will be looking to next week’s FOMC statement and economic projections for further clues about the pace of tightening through the remainder of 2017.16 As of Friday, Fed fund futures were pricing in three rate hikes in 2017, with the implied probability of a hike at next week’s meeting sitting at 100%.17

Chart of the week: Long rates relatively anchored

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The implied probability that the FOMC will raise interest rates at its March meeting rose from an already-high 90% last week to 100% this week.17 The movement came after Fed Chair Janet Yellen clearly laid the groundwork for a March hike last Friday and as February employment data came in stronger than expected this week.15,18

Treasury rates climbed through most of the week, with the benchmark 10-year Treasury note returning to its December 2016 high and briefly crossing the 2.60% mark once again.2

As we noted last week, however, there continues to be a notable dynamic taking place within the rates markets. Specifically, investors are pricing in higher growth and inflation expectations in the short term, but still do not appear to expect faster economic growth or significantly higher inflation to take hold over a longer period of time.

The chart highlights this phenomenon. Specifically, it shows that the yield differential between 5-year and 30-year Treasury notes has generally been narrowing since its peak in November 2010. In the current cycle, this is because yields on 5-year Treasury notes have risen much faster than those on 30-year Treasury bonds.19

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